Nov 12 - The rebuild costs and lost revenue caused by Hurricane Sandy are unlikely to lead to widespread downgrades across Fitch’s rated portfolio, Fitch Ratings says. But the credit profiles of some individual borrowers will suffer a short-term hit. Losses from Sandy will be borne by a combination of insurance/reinsurance companies, local governments and the federal government. Some losses will also be borne by individuals and businesses who are uninsured and will not be supported by any government programs, as well as certain investors in real estate-related assets and securities.
The ultimate amount of economic loss from Sandy is not yet known, while preliminary estimates made by catastrophe-modelling firms are in the USD30bn-50bn range. Losses remain difficult to estimate given the widespread nature of the storm, widespread and long enduring power outages, and challenges in estimating the magnitude of business interruption.
From an insurance industry perspective, preliminary estimates of insured losses from modelling firms are USD10bn-20bn. If losses reach the upper end of the estimated range, reinsurers will start to take on more of the insured loss exposure. At such loss levels, we do not expect Sandy to result in a widespread hardening in insurance or reinsurance pricing.
Because of uncertainty about ultimate loss levels, we have analysed several scenarios as they would affect US primary insurers, including an extreme scenario in which we doubled expected insured losses to USD40bn. Even under this extreme scenario, we do not expect rating changes for most individual US property/casualty insurers. We consider State Farm Mutual Group, Allstate Corporation and Liberty Mutual Group to have the largest potential insured losses. From a reinsurance industry perspective, we have previously said that losses from a single catastrophe would need to exceed USD60bn to trigger widespread downgrades.
Public finances are most likely to be affected at the local level where costs are concentrated, rather than at the federal level where they will be easily absorbed within the government’s USD3trn annual spending.
The largest public finance cost will be rebuilding transport and power infrastructure. The absolute increase in costs related to system recovery and repair will be manageable with insurance proceeds, and emergency federal and state assistance. In the short term, we expect issuers to change spending plans to manage net added costs by deferring less essential operating and capital spending. Municipal utility and transport issuers in the affected area are likely to experience near-term operational disruption, but generally maintain sufficient resources and liquidity to buffer the financial and rating impact until more permanent funding arrangements are secured. One exception may be the Long Island Power Authority, which is faced with unprecedented system repairs and related costs.
The long-term implications for these systems are more uncertain, as they may choose to modify and enhance system protections to prevent damage from future events. Very significant costs would also be beyond the ability of issuers like the New York Metropolitan Transportation Authority to absorb without a significant reprioritisation of current major capital projects and/or external support.
Most tax-supported debt in the affected region is backed by property taxes, mainly through the issuer’s general obligation. Some bonds are supported by broad sales or income taxes. The highest level of risk is likely to be in areas where rebuilding is prolonged, incomplete, costly to the locality, or in which population emigration appears long-lasting. This could reduce the community’s tax base or impair its growth potential.
There could be near-term financial pressure on hospitals in the affected areas due to increased expenses related to damage and preparedness, in addition to loss revenue from closed facilities or the inability of patients or physicians to reach the facility. Most higher-education institutions with some facility damage can manage the increased costs associated with repairs. We will monitor any that remain closed for an extended period because of more extensive damage, to determine whether there will be longer-term negative repercussions - including that on student demand.
Banks, particularly those with concentrated activities in the affected region, will experience some earnings pressure, driven by operational recovery costs as well as fee waivers, loan payment deferrals and emergency loan programs that will temporarily affect asset quality. Longer-term problems could occur in small business loan portfolios if reduced economic activity in hard-hit areas puts pressure on past-due and non-accrual loan balances.
Delinquency rates in residential mortgage books are likely to spike temporarily, but asset-quality trends should return toward pre-Sandy levels within a year, depending upon the flow of insurance proceeds and FEMA payments to affected homeowners. This would mirror patterns seen after Hurricane Katrina, when Louisiana banks saw asset-quality metrics return to pre-storm levels by late-2006, just over a year after the storm hit.
In the months immediately after Katrina, mortgage delinquencies rose dramatically in the areas directly affected, almost tripling from 17% to 45% of all loans outstanding. But within a year, as those temporarily displaced returned, insurance proceeds were received. As businesses returned to normal, delinquency quickly improved to 25% in the areas affected - about 1.4x up on the level before the storm.
A similar 1.4x delinquency increase in the areas most affected by Sandy would generally have a modest overall impact on RMBS pools because the states of New York, New Jersey and Pennsylvania only account for about 12% of outstanding RMBS mortgage loans.
Most mortgage origination in flood plains depends on flood insurance or benefits from Federal Emergency Management Agency guarantees. Home purchases above the cap on FEMA insurance payouts are normally financed through cash.
CMBS loan defaults could rise, but many will be cured as power and connectivity issues are resolved. However, it may take some time to resolve these loans if borrowers with property damage experience delays in receiving insurance proceeds, making repairs and resuming operations. The level of insurance coverage will vary from building to building. We are currently assessing the risks to each loan given the technical differences between surge and flood coverage, and do not expect to take widespread rating actions.